Microsoft Deepens Indemnity

None of this is lost on business-technology decision makers. "I have a lot of conversations with my various software vendors to make sure we stay on the right side of the licensing questions," says Mike Green, CIO of United Pipe & Supply, which sells water-distribution equipment for irrigation and golf courses. One software vendor recently pitched a Linux-based product to United Pipe. Says Green, "I'm asking, 'What flavor of Linux?'"

Customer protection is just one aspect of a broadening intellectual-property strategy at Microsoft that's putting greater emphasis on patents and cross-licensing arrangements and less on its trade-secret approach of the past. Kaefer says there are five underpinnings to Microsoft's new model: using process controls to track the origins of software; securing intellectual-property rights through patents and other techniques; acquiring rights for third-party software used by Microsoft; licensing its software; and protecting customers via indemnification.

In the process, Microsoft is building up its own patent portfolio. Chairman Bill Gates estimated this summer that Microsoft would file 3,000 software patents in fiscal 2005, a 50% increase over this year. Kaefer refers to patents as the "currency of exchange" used by vendors to assemble the technologies they need to build products without reverse engineering another company's approach or other workarounds.

Patents also yield clout. "The more patents you hold, the more likely you are to legitimately restrain others from entering your market. That's what patents do," says Brian Beatus, a partner with the law firm of Pillsbury Winthrop LLP and head of its Silicon Valley IP group. For this reason, Linux distributor Red Hat Inc. argues that software patents impede innovation. Red Hat has begun filing for patents, too, but only for what it describes as "defensive purposes."

In the past 12 months, Microsoft has reached cross-licensing deals with Cisco Systems, SAP, Siemens, and Sun, and it has existing agreements with Hewlett-Packard, IBM, Unisys, and Xerox. The goal is to strike more of these deals, in which Microsoft doles out its patents in order to gain access to those of other companies. "If you can put deals [like these] in place, you can solve 80% to 90% of the patent puzzle," Kaefer says.

Microsoft isn't immune to intellectual-property disputes. In early April, the company agreed to pay Sun $900 million to resolve patent issues and $350 million in royalties. A few days later, it disclosed plans to pay InterTrust Technologies Corp. $440 million for access to that company's patented digital-rights-management software.

And the U.S. Patent and Trademark Office is re-examining patents awarded to Microsoft for its File Allocation Table file system, an early version of which was developed by Gates in 1976. Microsoft plans to respond to the Patent Office inquiry within 60 days.

Going forward, Microsoft will seek more licensing agreements of the type revealed in early October with PalmOne Inc., which will use Microsoft's ActiveSync protocol for wireless E-mail synchronization between Palm OS-based smart phones and Microsoft's Exchange Server.

Microsoft also continues to expand its 3-year-old Shared Source Initiative, through which it makes source code for Windows and other products available to customers, outside developers, and students, under Microsoft's terms and conditions. For instance, Microsoft recently opened the source code to its Office 2003 applications suite to government agencies that qualify for its government security program. More than a million people have participated in Microsoft's shared-source program.

Microsoft also is assessing how its technology gets absorbed into the evolving world of Web services. In the months ahead, Kaefer says, it plans to be more "prescriptive" about when its .Net Web services code is available for royalty-free use.